II. Overview

In Exchange Act Release No. 34-48301 (August 8, 2003), the Commission solicited comment regarding proposals to increase the transparency of nominating committee functions and communications between security holders and boards of directors. The 147 commenters who responded were comprised of the following groups:

54 individuals;

36 social, environmental, and religious funds and related service providers;

The majority of unions, pension funds, institutional investors, institutional investor associations, and individuals supported the rules. Many of these commenters emphasized that, while they supported the proposed rules, they are a first step and the proposals related to security holder director nominations are necessary to address issues related to director accountability and accessibility.1

The majority of corporations, law firms, and attorneys either opposed the proposed rules or supported the general premise of the rules but suggested several modifications. Several of the commenters who opposed the rules recommended that the Commission not adopt or defer implementing the proposed rules until the Commission has had time to assess the impact of the Sarbanes-Oxley Act of 2002 and the self-regulatory organizations' amendments to their listing standards. Other general concerns included the possibility that the proposals would go beyond disclosure and influence corporate behavior and/or result in boilerplate, rather than meaningful disclosure.

The proposal that generated the most comment related to requiring disclosure of specific information regarding consideration of candidates submitted by large, long-term security holders or groups of security holders. Several commenters did not see the need for treating a 3% security holder any differently from other security holders. Other commenters expressed concern about the requirement that companies state the specific reasons for not including a candidate as a nominee. These commenters noted that decisions with respect to nominees are not subject to a precise formula and that the proposed disclosure could be embarrassing to candidates, raise privacy concerns, create litigation risks, and discourage service on nominating committees. Commenters also varied on the appropriate ownership and holding period threshold to trigger disclosure. In this regard, commenters supported thresholds ranging from no ownership requirement to a 10% ownership requirement, with commenters expressing the most support for a 3% or 5% ownership requirement. With regard to the length of ownership, comments ranged from requiring no past ownership to a period of 5 years.

The remaining proposals that generated the most comment included the following:

The qualifications and standards for director nominees  companies, law firms, and bar associations stated their belief that nominating committees do not apply objective, quantifiable standards in selecting nominees to the board. Commenters noted that this disclosure likely would be broad and general in nature because boards would not want to be held to specific standards, which could potentially expose companies to litigation risk.

The source of candidates other than executive officers and those standing for re-election  companies, law firms, and bar associations noted that disclosing the source of candidates would be difficult. These commenters noted that the nominating process is a collaborative effort involving multiple parties and there may be no clear "source" in this process. Commenters also noted that a potential unintended consequence would be that individuals and entities would be less likely to submit candidates to the board, resulting in less qualified directors.

A description of material actions taken as a result of security holder communications with the board  several commenters were critical of this part of the proposed rule. Commenters stated the view that it may be unclear what would constitute a "material action." Several commenters noted that boards make decisions based on input from a variety of sources and it would be difficult to attribute the decision to a particular source. Commenters also noted that this proposal may have the unintended consequence of discouraging communications between security holders and boards for fear of triggering the disclosure requirements.

III. General Observations

A. Comments Expressing Support for the Proposed Rules

The majority of commenters expressed general support for the proposed rules.2 Many of these commenters noted that the proposed rules are an important first step, but noted that more action is needed in the area of director nominations.3 Specifically, these commenters sought reforms that would make it easier for security holder nominees to be included in company proxy materials.4 These commenters believed that these two steps would improve investor confidence5 and board accountability.6

Commenters also expressed concern that the proposed rules would prevent other, more important rules related to security holder director nominations from being adopted.7 As two commenters explained, "[W]e are concerned that the SEC might perceive the inevitable wave of favorable comments on the first disclosure proposal as a sign that improved disclosure would be an adequate response to investor concerns about the Board nominating process."8 Three commenters recommended that the Commission delay further action on the proposed rules until rules related to security holder director nominations are adopted.9

Despite the focus on the need for further rules regarding security holder nominations, one commenter emphasized the importance of the proposed rules.10 This commenter noted that future changes relating to the inclusion of security holder nominees in company proxy materials would not negate the need for open disclosure and explained, "Disclosure provides potential investors and potential directors with a way to compare the processes one board uses to nominate directors and its policies with respect to those nominations-with those of other boards-before they choose to invest or undertake a process to be considered for directorship."11

B. Comments Expressing Opposition to the Proposed Rules

A minority of commenters opposed the proposed rules and cited a number of reasons the proposed rules should not be adopted or should be revised.12 Some commenters recommended that the Commission defer or not adopt the proposed rules because they are not timely.13 These commenters recommended that the Commission permit full implementation of the Sarbanes-Oxley Act and the New York Stock Exchange and the Nasdaq Stock Market's amendments to listing standards before proposing any additional rules regarding the director election process.14 Citing the magnitude of the changes that will result from the measures cited above, one commenter believed it is impossible to determine whether or not the Commission's proposed rules are necessary or the best way to proceed.15

Other commenters were concerned with the efficacy of the proposed rules. Some commenters believed that the proposed rules would provide little or no benefit.16 Commenters also suggested that the proposed rules would not provide meaningful disclosure.17 Many commenters believed that any resulting disclosure would be boilerplate.18 One commenter believed that the proposed disclosure requirements will "add to the false and misleading impression that most companies present regarding their boards of directors."19 Other commenters noted that the proposals fail to address whether directors are accountable for their actions.20

C. Federal Authority

One commenter noted that the proposed disclosure requirements should be "designed to provide transparency, without unnecessary complexity, to enable security holders to make informed decisions regarding the company's governance."21 This commenter noted that certain of the proposals go beyond material disclosure and may have the effect of intruding unnecessarily on companies' corporate governance processes by requiring a discussion and justification of a practice (e.g., specific reasons why a potential nominee submitted by a greater than 3% holder has not been nominated).22 Four commenters believed that the proposed rules would have an impact on corporate conduct and structure.23 One commenter believed that past efforts to use disclosure to influence board behavior have not worked.24 Two commenters noted that it might not be appropriate for the Commission to require additional disclosure to increase board accountability.25 These commenters explained that the proposed rules would have the effect of influencing board action, which traditionally has been regulated by state corporate law.26 Another commenter urged the Commission to consider whether a disclosure requirement regarding the independence of nominating committee members of unlisted companies establishes a governance requirement for companies.27 Another commenter believed that the details of corporate governance should be left to the private sector through the NYSE and Nasdaq listing standards and corporate boards. This commenter suggested that the Commission request that the NYSE and Nasdaq amend their listing standards to require companies to have a process for considering security holder nominees and ensuring that directors are fully informed.28

IV. Enhanced Nominating Committee Disclosure

A. General Comments

1. Observations About the Nomination Process

Several commenters were of the opinion that security holder nominees are rarely given consideration by management during the nomination process.29 These commenters explained that the only other alternative available to security holders who wish to effect a change in the composition of the board of directors is an election contest, which is time-consuming, expensive, and rarely successful.30

Other commenters discussed the efficacy of the existing nomination process. The BRT noted that two-thirds of its members have a process in place regarding security holder nominations of board candidates. Two commenters believed that current director nomination procedures are sufficient to allow security holders to participate meaningfully in the nomination process, including making public statements, conducting private discussions with management and security holders, making proposals under Exchange Act Rule 14a-8, voting against management proposals, withholding authority for directors, proposing potential candidates to the nominating committee, and conducting election contests.31

One commenter noted that the proposed disclosure related to nomination procedures would not provide security holders with useful, additional information.32 This commenter noted that companies must disclose currently whether the nominating committee will consider nominees from security holders and noted that the NYSE listing standards (i.e., sections 303A(4) and 303A(9)) would provide information regarding the nomination process on companies' websites.33

One commenter noted that the proposed rules would not prevent boards from ignoring security holder recommendations,34 while another commenter stated that the new disclosure would aggravate the existing practice of companies presenting director nominees as distinguished individuals regardless of their qualifications.35 One commenter noted that some companies already disclose much of the substance of the proposed rules, so the new proposals are merely a "codification of best practices."36 Another commenter urged the Commission to "keep in mind the corporate law principle that a nominating committee is appointed by the board of directors ... The Commission should avoid any implication ... that the board of directors has no role or authority in that process."37

B. Responses to Questions Regarding Nominating Committee Functions

1. Would increased disclosure related to the nominating committee and its policies and criteria for considering nominees be an effective means to increase security holder understanding of the nominating process, board accountability, board responsiveness, and corporate governance policies?

There was no clear consensus on whether the proposed rules would be an effective means to increasesecurity holder understanding of the nominating process, board accountability, board responsiveness, and corporate governance policies. The majority of commenters who supported the proposed rules believed that increased disclosure about the nominating committee would be effective in increasing security holder understanding of the nomination process,38 board accountability,39 board responsiveness, and a company's corporate governance policies.40

Other commenters believed that the proposed rules would not increase security holders' understanding of the nominating committee process41 or solve the problem of director accountability.42 Rather, commenters noted the resulting disclosure likely would be boilerplate.43 One commenter believed that the proposed rules would not boost the ability of investors and the public to make informed investment decisions efficiently.44

2. (a) Do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with useful information that provides an understanding of a company's nominating process:

Commenters responded to parts of this question, as noted below.

the existence of a nominating committee;

One commenter believed that investors "don't really care very much" whether a nominating committee exists.45 Another commenter noted that companies already must disclose whether they have a nominating committee, the members of the committee, the number of committee meetings, and the functions performed by the committee.46 Another commenter recommended elimination of the proposed requirement that companies state their basis for not having a nominating committee.47 This commenter noted, "[A]s long as nominations are made by independent directors, it should not make any difference to the stockholders whether the nomination is made by an independent nominating committee or by a majority of independent directors who serve on the board."48

the nominating committee charter, if any;

One commenter did not believe that investors would be interested in whether a company has a nominating committee charter.49

One commenter recommended that the Commission also require companies to disclose whether directors are independent under state law.50

the process for identifying and evaluating candidates;

One commenter stated his belief that information regarding the process for identifying and evaluating candidates is not necessary because security holders already understand the proxy process regarding the nomination and election of directors.51

Two commenters noted that that the evaluation of board candidates is a dynamic process.52 Another commenter voiced similar concerns, noting that any written description of the process, beyond what already appears in the proxy, would either be "inaccurate or not helpful, since the process may vary from time to time or depend on the candidate under consideration."53 In addition, a security holder would have access to the nominating committee charter and be fully informed about the process for submitting director nominations.54

the qualifications and standards for director nominees;

One commenter believed that minimum director qualification standards should be disclosed.55 Another commenter, however, noted that companies could avoid describing any minimum standards by not adopting any standards.56

Five commenters noted that evaluation of the precise qualities for a director could not be reduced to a formula.57 One commenter explained that the proposal to require disclosure of minimum qualifications rests on an erroneous assumption that there are or should be objective and quantifiable standards that a nominating committee applies in selecting nominees for the board.58 Rather, this commenter explained that the attributes of an ideal director "are impossible to measure with precision" and depend on factors such as "the existing composition of the board, the company's business objectives, the regulatory environment and other developments that cannot be imagined in advance."59 This commenter also noted that the weight given to the various attributes may change over time and any attempt to state and follow these standards would "deprive stockholders of a nominating committee's best judgment at the time."60 One commenter noted that the " industry has not recognized or agreed upon the traits or skills of an `ideal' director."61

Four commenters noted that the board must have the flexibility to determine whether to nominate a director.62 Another commenter concluded that the description of such criteria must therefore be broad and general in nature.63 As such, two commenters suggested that the disclosure requirements be simplified to call only for any pre-established criteria or qualifications for nominees, and that any further elaboration would produce only boilerplate language.64 Another commenter noted that the NYSE listing standards (i.e., section 303A(9)) will require companies to set forth director qualification standards on companies' websites.65

Another commenter noted that the "realities of the marketplace will most likely result in generalized requirements for the qualifications and skills of a typical director as well as for the company's process for consideration of director candidates."66 This commenter also was concerned that nominating committees could be limited to the specific criteria disclosed with regard to director qualifications and suggested that companies that nominated a candidate who did not meet the specified criteria could be exposed to litigation risk.67

the source of candidates other than those standing for re-election; and

Eight commenters noted that disclosing the specific source would be difficult.68 Expanding upon that statement, one commenter noted, "Typically, director nominees do not have `sponsors.'"69 This commenter explained that suggestions for nominees come from a wide variety of sources and the suggestions then are given to the nominating committee to further explore.70 The nominating committee then recommends to the full board candidates to be included in the proxy statement.71 As such, the source of each nominee is the nominating committee.72 Thus, in the view of this commenter, disclosure of the "source" of each director nominee would not provide meaningful information to security holders.73 According to another commenter, "[t]he process by which a potential director becomes a full-fledged nominee may be a long and multi-layered one"74 and, as a result, identification of a specific source is difficult.75 This commenter explained, "[a] suggestion by one director may be taken up by another, who then becomes an advocate, but the actual contact may be made by yet another member of the board" so that the actual source of the nomination may be unclear or difficult to explain.76 Another commenter stated its belief that it is not necessarily clear which source has influenced committee or board members.77 One commenter noted that the nominating process is a "collaborative" one.78 One commenter stated that although the term "source" is ambiguous, if a source must be identified, the person named should be the person who recommends or sponsors a candidate to the nominating committee.79

One commenter believed that a nomination is the responsibility of the nominating committee, so disclosure of who first recommended the nominee would be of limited relevance.80 Another commenter stated its belief that requiring identification of a source "serves no useful purpose other than to suggest that a director may not be qualified or independent based solely on the source of the nomination. The premise of this part of the proposal appears to be that a director nominee, otherwise qualified to serve, who was first brought to the attention of the committee by the chief executive officer, may be suspect."81 This commenter also noted that the NYSE, Nasdaq and American Stock Exchange had proposed "new and more stringent criteria for independent directors."82 Another commenter observed that the "more important and relevant" consideration is whether the source is independent and explained, "This, we believe, is more central and informative than trying to describe the source of a nominee or `connections' that may exist between nominees, on one hand, and the company and the nominating party, on the other hand."83

Three commenters believed that identifying specifically the individual who recommended a candidate would have a chilling effect on the search process.84 Another commenter stated that identifying the source would "have a counter-productive and disruptive effect on the search process."85 One commenter noted that identifying the source might reduce the number of qualified directors.86 Another commenter noted that identification of the source might bias security holders.87 One commenter cautioned that identifying the source might expose the source to litigation risk should the director later be found to have been negligent in performing his/her duties as a director.88

the involvement of third parties receiving compensation for identifying and evaluating candidates?

No commenters responded to this question.

(b) Do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with useful information that provides an understanding of the ability of security holders to participate in the nominating process:

policies for consideration of security holder candidates;

One commenter noted that, to the extent a corporation would not consider recommendations from security holders, "it would seem incongruous that the corporation would have a policy regarding that practice."89 Another commenter believed that this proposed requirement would result in boilerplate disclosure. In support of its belief, this commenter explained, "Any policy of the nominating committee must be broad and vague enough to provide the board with maximum flexibility in dealing with these varying circumstances."90

One commenter noted that it is unclear whether a company must disclose the requirements related to the nominating process if it does not have a nominating committee.91 One commenter noted that requiring disclosure of the nominating policy implies that the policy cannot simply be that the committee will consider such candidates.92 This commenter also recommended that, with regard to consideration of security holder nominees, the rule proposal be clarified to limit disclosure to the material terms of the nominating committee's policy and procedures.93

One commenter recommended clarifying the disclosure requirement related to a company's policy for consideration of security holder candidates to note that the provision covers not only the board but also committees and individual members.94

One commenter stated its belief that the proposed disclosure requirement creates an implication that nominees proposed by large security holders are more worthy of consideration.95 This commenter noted that this is contrary to state corporate law requirements, which do not differentiate in their treatment of security holders.96 Another commenter noted, "There is no basis in corporation law for treating a three-percent stockholder any differently from a stockholder with one share."97

One commenter noted that disclosing the specific reason for the nominating committee's determination not to include a candidate recommended by a security holder or group of security holders who owned over 3% of the company's voting stock for at least one year is not material because the nominating committee's determination will involve considerations specific to that individual.98

One commenter believed that the additional disclosure required for recommendations by security holders who owned over 3% of the company's voting stock for at least one year is not necessary because the disclosure is not related to the process followed by nominating committees.99 This commenter explained that the nominating committee has a duty to act in the best interest of the company regardless of the size of the recommending security holder.100 One commenter noted that disclosure as to a particular rejected candidate would not present a complete picture as to the overall process followed by the nominating committee and might attach greater importance to the candidate than is appropriate.101 Another commenter recommended not adopting the enhanced disclosure for a greater than 3% security holder, noting that the disclosure effectively requires that the nominating committee justify its actions publicly.102 One commenter noted that "significant security holders are quite able to make their views known to a nominating committee."103 The commenter further stated that it "[did] not understand the relevance of the proposed three percent, or any other percentage, threshold."104

Four commenters believed that explanations as to why a particular nominee was rejected should not be required because it is impossible to describe in a coherent and informative way the standards a nominating committee is applying at any particular time.105 One commenter also noted that the reason could become so amorphous as to be meaningless to security holders.106 Similarly, another commenter stated, "While ideally we might agree that providing the reason behind the nominating committee's rejection of a recommended nominee could be beneficial disclosure, decisions with respect to nominees are not subject to a precise formula."107 One commenter noted that the proposed disclosure of the reasons for rejecting a candidate would invade the privacy of members of the nominating committee; potentially result in embarrassment and ridicule for the rejected candidate; expose the company and/or nominating committee to the risk of litigation for defamation; and discourage board members from serving on nominating committees.108

One commenter urged the Commission not to adopt the disclosure requirement that companies state the specific reason for not including a candidate as a nominee.109 This commenter, however, did not object to "a requirement that the nominating committee communicate to the shareholder(s) who proposed the candidate the reasons why the candidate was not nominated."110

With regard to the general appropriateness of the proposed standards, one commenter recommended that the rule specifically state that the company's disclosure requirements should not apply to any recommendation that has been withdrawn by the recommending security holder prior to the date of the company's proxy statement.111

3. As noted above, the proposed disclosure requirements are intended to provide security holders with detailed, specific information that we believe is important.

Are there alternative means to better achieve our objective?

One commenter suggested a short-form nominating committee report for companies that have disclosed their nominating committee charter and corporate governance guidelines. The report would include disclosure of the existence of a nominating committee and the identity and independence of its members; the existence of a nominating committee charter and corporate governance guidelines relating to the qualification of the directors, if any, and a statement of where or how a security holder may obtain a copy of the charter; the general process undertaken by the nominating committee in its search for qualified candidates, including use of third-party search firms or advisors, where material; the number of candidate recommendations received from security holders and the names of the candidate and the recommending security holder; and the number of candidates nominated for election to the board of directors. In this regard, companies that do not have a publicly available nominating committee charter and qualification guidelines would provide a summary of the nominating committee charter, qualification requirements of directors, and the process of determining nominees.112

One commenter believed that requiring companies to disclose four or five of the most significant qualifications necessary for board membership would provide more useful information than the proposed disclosures.113

For example, would it be more appropriate to include a broader, less detailed disclosure standard? Would any of the detailed disclosure requirements within the proposed standard result in disclosure that is unnecessarily detailed for the purpose of providing security holders with useful information regarding the management of the companies in which they invest? If so, describe specifically the basis for that conclusion.

Five commenters suggested that broader, less detailed disclosure would better achieve the objectives of the proposed rules.114 Two commenters suggested that, in order to avoid the disclosure becoming a boilerplate checklist of information, the Commission should require detailed discussions of the process followed for nominating directors and how security holders can participate in that process.115 One commenter expressed the position that the specific requirements are not necessary to elicit the information that will be most valuable to security holders.116

Some commenters, however, were of the belief that detailed, specific information would provide useful information to security holders.117 One commenter believed that "broader, less detailed disclosure standards become boilerplate and of limited help to investors."118 One commenter stated, "None of the proposed requirements is overly detailed, and more general disclosure would not accomplish the goals set forth in the Release."119 Another commenter stated, "The proposed disclosure action strikes a good balance, calling for disclosure that will provide insight into the nominating and election processes, while not overloading company proxy materials with information that might make the document a less practical and helpful tool for security holders."120

4. We propose to require disclosure of the material terms of the nominating committee charter.

Instead of requiring companies to disclose the material terms of the charter, should we require that the company attach the nominating committee charter to the proxy statement?

One commenter recommended eliminating the requirement that a company disclose the materials terms of a nominating committee charter because it "will not add to an investor's overall knowledge of the nominating committee process and will only lead to boilerplate disclosures about the nominating committee charter and its purposes."121

Another commenter recommended attaching the charter in the year following its adoption, incorporating the charter by reference in future years, and posting the charter on the website.122

One commenter noted that the nominating functions of a nominating committee are only part of the committee's responsibilities and that attaching the nominating committee charter or describing the material terms could "go far beyond the nominating function" and could add length to and diminish the relevancy of the proxy statement.123

If so, should companies be required to attach it every year?

One commenter stated it would not object to including the charter in the proxy statement at some periodic interval, such as every third year.124 Another commenter noted that, because the audit committee charter is only required to be published in the proxy statement once every three years, it did not believe it appropriate to have more rigorous standards for the nominating committee charter.125

Should we require that the charter be filed with the Commission?

One commenter supported requiring corporations to file their nominating committee charters with the Commission.126

Should we require disclosure of any (or only material) amendments to the charter?

One commenter supported identifying any material changes in the proxy.127

Does website disclosure provide sufficient access to investors?

Three commenters believed that summarizing the nominating committee charter in the proxy and having the charter available on a company's website is sufficient.128

Several other commenters suggested that companies be required to post their nominating committee charters on their websites rather than disclose the material terms of a nominating committee charter in their proxy materials.129 One commenter explained that this would enable security holders to access the information without adding pages to company proxy statements.130 Two commenters noted that companies would be required to post their charters on their websites under the NYSE listing standards.131

Should companies be required to provide investors a copy of the charter upon request?

Seven commenters noted that the charter should be available in print to anyone who requests it.132

5. We propose to require disclosure of any instances where a member of a company's nominating committee did not satisfy the applicable listing requirements for independence. In addition, we propose to require similar disclosure for unlisted companies.

We request comment on whether the disclosures will help inform investors about the independence of the nominating committee. If the markets do not adopt the proposed amendments to the listing standards, are there disclosures that we could require that would achieve the same purposes?

One commenter believed that "it is doubtful that any of the current reforms now under discussion will ensure that directors are truly independent. Executive officer influence over the nominating process cannot be eliminated. Similarly, no definition of independence can capture the myriad of relationships and interests that impair a director's ability to make decisions in a neutral fashion."133

The majority of commenters, however, appeared to support disclosure related to a director's independence. Several commenters recommended that companies be required to describe the independence of each member of the nominating committee.134 Three commenters recommended that the Commission adopt a uniform definition of independence applicable to all directors without regard to their listing status.135 Three other commenters recommended enhanced disclosure of relationships between directors, corporations, and corporate executives to enable investors to make their "own assessments of a director's independence."136 Another commenter recommended additional disclosure by corporations "concerning the full range of business relationships maintained between businesses and organizations associated with each director and the corporation."137

Should we require companies whose securities are not listed on an exchange or quoted in the Nasdaq Stock Market to disclose whether the members of their nominating committee, if any, meet any of the independence definitions of the proposed amendments to the listing standards? Is it appropriate to let issuers choose which definition?

Two commenters believed that a company should not be required to disclose whether its nominating committee members are independent if it is not required to have an independent nominating committee.138 Expanding on this position, one of those commenters was of the view that it is inappropriate to ask a company that does not have an independent nominating committee to analyze each member's independence based on an unfamiliar definition of independence solely for the proposed disclosure.139

Two commenters believed companies should be required to disclose whether each member of its nominating committee is independent regardless of whether the company is listed on an exchange.140 One commenter noted, "As proposed, an unlisted company would have to disclose every year in its proxy statement whether each member of its nominating committee is independent (using a definition of independence of a national securities exchange or a national securities association) whereas listed companies would only disclose the instances during the last fiscal year where any member of the nominating committee did not satisfy the definition of independence in the listing standards of the market on which they are listed or quoted."141 This commenter did not see any "reason why there should be a disparity in treatment between listed and unlisted companies. In both cases, stockholders should be interested in knowing only whether the directors who nominate board members are independent or have lost their independence."142

One commenter recommended that, if an independence requirement is retained for unlisted companies in the final rules, the requirements should be clarified in two respects: 1) the company should be required to identify the individuals or corporate body that has made the determination of independence; and 2) any conclusions of independence or non-independence need to be presented.143

One commenter recommended that the Commission "broaden this
requirement to include all board members, and to require that companies indicate the nature of activities that would compromise independence."144

Should disclosure be required even if the noncompliance has been cured by the time the proxy statement is prepared?

One commenter believed that if the noncompliance has been cured by the time the proxy statement is prepared, this should be noted in the proxy.145

Another commenter noted, "`instances' where a director was not independent are inconsistent with the proposed SRO corporate governance listing standards, which tie director independence to affirmative determinations by the board of directors. In addition, all of the proposed SRO standards contain `look-back' tests for independence and therefore any problematic relationships with the company would prevent the director from being currently independent."146 This commenter recommended that the Commission conform the proposed rules to "Item 7(d)(iv) [sic] of Schedule 14A."147

Another commenter stated that the failure to maintain independence is an "interpretative matter."148 This commenter noted, "As a general matter it is standard practice for self-regulatory organizations to work with listed companies respecting compliance and to provide an opportunity to cure any failure to remain in compliance. This is an ordinary course event and is very much in the interests of investors. Disclosure of noncompliance may result in loss of the opportunity to cure and create other problems for the company."149

6. We propose to require disclosure concerning a nominating committee's policy with regard to the consideration of security holder recommendations. If a committee has no policy, should we require the company to disclose the reason it does not have a policy? In the absence of a formal policy, are there other disclosures a company should be required to provide to investors to help them understand the standard(s) a committee uses in determining a suitable candidate?

Three commenters believed that a company should disclose the reason it does not have a policy.150 One commenter recommended that companies be required to disclose whether or not the full board or the nominating committee ever formally considered implementing such a process. In the absence of such a policy, this commenter posited, a company should be required to provide detailed information on the qualifications sought in board candidates and there should be an explanation of how new board nominees advanced by the nominating committee meet the established director qualification standards.151

7. Where security holders have the ability to recommend a nominee for a company's board of directors, meaningful participation by security holders should be facilitated by disclosure of information regarding the process for security holder nominations. As such, we have proposed to require disclosure of the procedures for submitting recommendations.

Should we require disclosure during the year of any changes made to the procedure, for example in the next Form 10-Q or Form 10-QSB or on Form 8-K?

Several commenters recommended that the Commission require companies to notify security holders of all changes to the nominating process.152 One commenter recommended disclosure in a "timely manner."153 Eight commenters recommended that changes be disclosed in an Exchange Act Form 8-K.154 One commenter explained that this would ensure that security holders are aware of relevant procedures.155 Two commenters recommended that any material changes in the process should be disclosed in the next Exchange Act Form 10-Q.156 One commenter recommended disclosure "once-per-year" in the proxy statement because "the nomination process is generally a slower, calendar-year process."157 One commenter recommended that the changes be disclosed on the company's website because the disclosure can be "effected on a more rapid basis."158 One commenter recommended that such changes "should be made on the web site, in appropriate security holder disclosure mailings, and brought to the attention of investors in next year's proxy statement."159

8. We have proposed requiring disclosure of information regarding criteria used by a nominating committee to screen nominee candidates and the minimal qualifications that the committee believes must be met by a nominee.

Are there other eligibility requirements or qualifications about which investors should be informed?

One commenter noted that security holder candidates should be required to be independent of both the company and the nominating security holder.160

Should we require the company to disclose when it chooses candidates who do not meet the criteria?

Two commenters believed that the Commission should require the company to disclose when it chooses candidates who do not meet the criteria.161 One commenter recommended that this disclosure be provided in an Exchange Act Form 8-K.162

Should there be a specific disclosure requirement as to whether the company applies the same criteria to candidates recommended by security holders as to company nominees?

Seven commenters believed that companies should be required to disclose whether the same criteria apply to candidates recommended by security holders as apply to company nominees.163 If there is a difference, two commenters believed that companies should be required to disclose the differences.164 One of these commenters explained that this would give security holders adequate information to identify and submit qualified director candidates.165 One commenter noted, "[W]e expect that all companies will claim that management nominees and security holder nominees are subject to the same level of examination and consideration."166

9. We have proposed that companies be required to describe the source of each of their nominees for director other than nominees who are executive officers or directors standing for re-election  including the name of each source  and their nominating committee's process for identifying and evaluating candidates.

In addition to the name of each candidate's sponsor, should we require disclosure of any financial interest between the candidate and sponsor? Should we require disclosure of any other interest?

One commenter recommended that companies be required to specify any relationships between the source and the company or an officer or director.167 Three commenters recommended that the Commission require disclosure of any financial interest between the candidate and sponsor.168 Five commenters further recommended that companies be required to disclose the sponsor's title and firm and any "professional, familial or financial relationship between the candidate, sponsor, company and company executives."169 Another commenter emphasized the importance of disclosing relationships between board candidates and their sponsors and the need for significant independent research to discover who has other ties beyond being an inside director.170 Lastly, one commenter cautioned against requiring disclosure of financial interests between a nominee and his or her sponsor, while at the same time not requiring disclosure of other relationships that may be more important than financial connections.171

Is the name of the source important to security holders?

At least seven commenters noted that the name and title of the source is important to security holders.172 Two commenters explained that disclosing the source for a new director allows security holders to determine conflicts of interests as well as the measure of independence board candidates have from management.173

Four commenters, however, believed that disclosing the name of the source for each nominee would not provide important information for security holders.174

Instead, should we require disclosure of the person's title (e.g., chief executive officer) or simply whether the source is an officer or director of the company?

Three commenters believed that it is adequate to identify a category such as senior management, board member, or search firm.175 Another commenter suggested disclosure of the position of the individual.176

Should we require the name of the source only where the source is a director of the company, an employee of the company, or related to a director or employee of the company? If the source is not a director, an employee, or related to a director or employee, should we permit the source to be identified by category rather than name (e.g., security holder, third party firm paid by the company)? Are the proposed exceptions to the requirement appropriate?

One commenter did not support disclosure of a source, but if disclosure is required, recommended that the trigger for disclosure be limited solely to circumstances where the CEO or the board's chairman recommends a candidate.177 Another commenter was slightly more expansive and believed that, if the Commission determines that the source is important, then the identity of the source should be disclosed in a generic fashion and in limited instances, such as when the source is a director or employee.178 Another commenter recommended identification of the source, including the name, if a director or officer made the recommendation.179

10. We have proposed requiring disclosure of information regarding the function performed by any third parties paid by the company.

Should we require a company to disclose the methodology the third party uses to select candidates?

One commenter supported providing a "general description of [the third party's] role."180

Another commenter supported a requirement directing companies to disclose the methodology used by third parties.181

Five commenters did not see the need for disclosing the methodology used by third parties to select candidates.182 One of these commenters noted that the methodology is "presumably proprietary" or would be so boilerplate as to provide meaningless disclosure.183 Another commenter noted that it was "unclear" what value this disclosure would provide to investors.184

Should we require a company to identify any such third parties?

One commenter did not see the need to identify the third party.185 Seven commenters, however, supported disclosing the name of third parties used to identify director candidates.186 Two of these commenters explained that identifying third parties and related relationships would aid investors in evaluating the independence and effectiveness of those third parties.187 Three of these commenters recommended that companies also be required to identify who retained the third party.188 Another commenter recommended requiring disclosure of the third party as well as whether the third party had performed any other services for the company or its senior officers in the recent past.189 Three commenters recommended that the Commission require disclosure of the fees paid to third parties.190 Two commenters did not believe disclosing the fee was necessary.191

11. We propose to require disclosure regarding candidates that were recommended by certain security holders and rejected by the nominating committee.

Would this type of disclosure raise privacy issues for rejected candidates, even if the candidates were not specifically named in the company's disclosure? Would it raise privacy issues for the recommending security holders?

One commenter noted that even if the rejected candidate's name is not required to be disclosed, it may be possible to infer the candidate's identity from the required disclosure, including the identification of the recommending security holder.192 According to several commenters, this disclosure might be embarrassing193 and damaging194 to the company and the candidate and also might raise privacy issues for the candidate.195 Two commenters noted that this disclosure would allow all investors to second guess the nominating committee's decisions without having access to all of the information used by the nominating committee to make its determination.196 Another commenter noted that this "would serve as much-sought-after publicity for so-called `activist' candidates."197 One commenter recommended leaving the discretion regarding this disclosure to the nominating committee.198 One commenter noted that this disclosure could result in frivolous litigation and should not be required because there are often "intangible" reasons one candidate is chosen over another.199

The proposed disclosure requirements with regard to rejected security holder-recommended candidates would not preclude a company from naming the candidates, though such disclosure would not be required under the proposed rule. Should the rule specify that companies should not disclose the names of rejected candidates? Should the rule specify that companies must include the name of any rejected candidate who consents to being so identified in the company's proxy statement?

One commenter urged the Commission to make clear that the name of a rejected security holder candidate need not be disclosed.200 Four commenters suggested including the name of the nominating security holder but not the name of the nominee, unless both parties consented to having the nomination made public.201 Another commenter believed that the "rejected nomination efforts should be noted, with the candidate's sponsor identified by name, and a brief explanation of the nominating committee's rational presented."202

Five commenters suggested that companies should have to identify rejected candidates who consent to be identified in the company's proxy materials.203 One of these commenters noted that this would allow security holders to assess the board's performance in the nominating process and decide whether to recommend candidates in the future.204 One commenter recommended identifying the candidate and the nominating security holder if they each agree to such identification.205

One commenter recommended requiring companies to disclose the name of the candidate, the nominating security holder, and the reason for rejection.206 Two commenters supported more expansive disclosure, including the names and addresses of nominating security holders and the security holder nominees, as well as the reason the board did not include the candidate in the proxy materials.207 One commenter recommended requiring the names of all rejected candidates and disclosure of the reasons for rejection.208

12. Are the proposed threshold requirements for a security holder recommendation that would trigger additional disclosure requirements by the company (i.e., recommendations from security holders that have beneficially held more than 3% of the company's securities for at least one year) appropriate?

Two commenters believed that the proposed 3% threshold is too high.209 One of these commenters believed that any "thoughtful nominee" should be given "due consideration."210

Two commenters supported a 3% ownership threshold.211 Two others recommended that the threshold be no higher than the proposed 3% and one-year holding period.212 Another commenter supported a 3% ownership requirement, but advocated that any security holder group be limited to 10 people, with each member of the group meeting the required holding period.213

Another commenter supported the 3% ownership threshold, but believed the disclosure requirement should not be coupled with an indication of intent to continue to hold the securities for some period of time.214 This commenter explained that requiring an intention to hold securities could be problematic for funds that hold company shares in an index because retention of the shares depends on inclusion in the index.215

If not, what ownership threshold, if any, would be appropriate (e.g., no threshold, 1%, 2%, 4%, 5%, or higher) and what holding period, if any, would be appropriate (e.g., no threshold, 2 years, 3 years, 4 years, or longer)? Should we use a different threshold, such as the three, four, or five largest security holders who are not directors or officers of the company?

Two commenters recommended a 1% ownership threshold.216 One of these commenters explained that the formation of a 3% or greater coalition would be uncommon.217

Another commenter recommended a 1% ownership threshold and a one-year holding period.218

A number of commenters suggested more stringent ownership and holding period thresholds. One commenter recommended a 5% ownership threshold, while maintaining that in no event should it be less than 3%.219 Three commenters recommended a 5% ownership threshold.220 Another commenter noted that a 3% threshold would be "relatively easy" to reach and therefore recommended a 5% threshold.221 One commenter suggested a 5% ownership threshold with a one-year holding requirement that is applied retrospectively and prospectively.222 One commenter recommended 5% ownership with a two-year holding period,223 while two other commenters recommended 5% ownership with a two-year holding period and a statement of intent to continue to hold the securities for one year.224 Another commenter suggested a 5% ownership threshold with at least a three-year holding period.225 Six of the commenters who supported a 5% ownership threshold explained that 5% is the level at which Congress decided an ownership interest is significant enough to require public disclosure.226

One commenter suggested a 10% ownership threshold,227 while another commenter suggested a 10% ownership threshold with a two-year holding period or, in the alternative, a 5% ownership threshold with a two-year holding period.228

One commenter suggested a five-year holding period to qualify as a long-term investor.229 This commenter also suggested that this holding period apply to all members of a nominating group and that any incentives offered to encourage group membership be disclosed.230

One commenter believed that each corporation should determine individually what ownership threshold to use.231

As proposed, the rules would not require that the nominating security holder indicate an intent to continue to own the securities for any specified period of time. Should we include such a requirement? If so, what is the appropriate period over which the security holder must intend to continue to own the securities (e.g., through the date of the related security holder meeting, six months after the recommendation, one year after the recommendation, or longer)?

Two commenters believed that the Commission should require the nominating security holder to indicate an intent to continue to own the securities.232 One commenter recommended a required intent to continue to own the securities for a one-year period.233 Two commenters believed that past ownership is "irrelevant and not required."234 One commenter recommended that nominating security holders be required to hold their securities for the nominee's initial term of office.235

Is the proposed method to determine whether a security holder or group of security holders meets the threshold requirements to trigger additional disclosure by the company appropriate? For example, are the means of proving ownership appropriate? If not, what would be a more appropriate means? Is it appropriate to calculate ownership as of the date of the recommendation? If not, what other date would be more appropriate? Should we include a specific method of determining beneficial ownership for purposes of this disclosure item? For example, should securities underlying options be included or excluded for purposes of calculating the ownership threshold?

One commenter expressed the view that any securities underlying options should be excluded for purposes of calculating the ownership threshold, although this commenter also stated that this should be evaluated on a case-by-case basis.236

One commenter recommended that the Commission provide more guidance on the definition of a "record holder."237

One commenter recommended that the method of calculating ownership be described in more detail  for example, it should specify the date on which the number of outstanding shares is to be calculated.238

13. Would the proposed disclosure requirements have unintended adverse effects on the nominating process? Would they increase the burdens on members of nominating committees or discourage service on nominating committees? If so, please provide specific reasons supporting your responses to these questions.

Two commenters expressed concern that the proposed rules would intrude unnecessarily into the boardroom and board processes. The commenters believed that requiring too much disclosure regarding how directors "think, act and operate" could be counterproductive.239 Several other commenters noted that, if disclosure of the nominating committee's deliberations were required, nominating committee members might not feel free to engage openly in discussions regarding the comparative merits of candidates for fear that the discussion would be made public.240 These commenters expressed concern that, because the qualities that make a good director are not easily measured and judgments must be applied, the disclosure requirements may inappropriately cause a nominating committee member to hesitate to voice any reservations about a security holder nominee in order to avoid disclosure that may be embarrassing to the company or a security holder.241 Another commenter offered a less specific critique, stating the belief that the proposed rules generally would be disruptive to the board.242

Four commenters believed that the proposed disclosure requirements would increase the burdens on members of nominating committees and/or discourage service on nominating committees.243 Expressing a similar concern, another commenter noted that the proposals would create a shortage of qualified directors.244

One commenter expressed concern that a company may nominate individuals that it does not consider the most qualified in order to avoid public relations problems or public debate about the merits of a particular individual.245 Another commenter believed that the proposed measures would function only as encouragement to self-interested organizations and would not operate in the best interests of disinterested common security holders.246 Two commenters expressed concern that security holders might use the disclosure requirements, as well as threats of a public relations campaign, proxy contest, or litigation, as leverage to pressure directors to buy out dissidents at a premium.247 These two commenters noted that the proposed rules might raise a litigation risk for companies.248

Finally, two commenters noted that, if companies were required to disclose minimum qualifications, companies would face increasing pressure to include various groups' notions of director qualifications.249

One commenter believed that the proposed disclosure items would be more appropriate on company websites than in company proxy materials.250

One commenter believed that all companies should have independent nominating committees and suggested that the Commission make this a requirement.251

One commenter suggested that the Commission collect specific data regarding nominating committees and make this information available to the public.252 This commenter also recommended that the Commission describe any policies and procedures it believes are best practices.253 This commenter also suggested that the Commission issue an opinion on the fairness of the nominating committee process at companies.254

Several commenters recommended an additional disclosure requirement regarding whether and how the nominating committee takes issues of diversity, including diversity of gender and race, into account when making recommendations for new board nominees.255 These commenters expressed the view that board diversity is an important factor in good governance.256 Echoing similar concerns, another commenter requested disclosure of how companies consider "board diversity and independence in the nominating committee process."257

Seven commenters recommended that the Commission clarify that security holders and security holder groups will not lose Exchange Act Schedule 13G status if they submit nominees for consideration by the nominating committee.258 Another commenter disagreed and recommended that "the new rules should be neutral on this point and that a determination as to whether recommendation of a candidate to a board falls within such broad, inclusive language ... should continue to be made on a case by case basis by the proposing security holder or security holder group in accordance with existing case law and rule interpretations."259 Another commenter agreed and noted, "there is no reason to assume that the interests and efforts of a particular 1%, 3% or 5% stockholder/group will be the same as those of other stockholders."260

One commenter suggested that companies be required to disclose how each member of the nominating committee voted with respect to a particular candidate.261

One commenter recommended that the proposed rules include an instruction specifying that if a rejected nominee has offered in writing a specific plan for the company, management should state its position on that plan and whether any differences over that plan were a factor in rejecting the nominee.262

Two commenters recommended that the Commission also require a statement from the nominating security holder as to whether it believes that the nominee is independent with respect to the company and the nominating security holder.263 One of these commenters specified that all material relationships of the recommended nominee with the proposing security holder or security holder group, including financial interests, should be furnished when a name is submitted to the nominating committee and recommended a statement requiring that the individual has been contacted, has agreed to have his or her name proposed, will serve the term if nominated and elected to the board, and, if applicable, meets the basic criteria for a nominee as set forth in the Nominating Committee Charter.264 This commenter further expressed the view that there should be disclosure of whether the security holder or recommended nominee has a specific agenda or matters that are the basis for the submission to the committee.265 One of these commenters recommended that the Commission further require a statement that the nominee would, if elected, be willing to serve on the board and would consent to a reasonable background check.266

Two commenters recommended that nominating security holders be required to make a representation regarding their ownership and intent to hold the securities.267 One of these commenters recommended that the security holder proponent be required to represent: (i) that it had maintained minimum holdings for the requisite time period, and (ii) that it intended to maintain such minimum holdings for some period beyond the shareholders' meeting to which the proxy statement relates.268 If the security holder does not hold the securities for some period beyond the shareholders' meeting, this commenter suggested that the security holder proponent and its affiliates should be banned from use of the rule for two years.269 Two commenters suggested using the timing and proof of ownership requirements in Exchange Act Rule 14a-8.270 One commenter also urged the staff to handle any disputes related to notice.271

One commenter recommended that any solicitation of security holders for the purpose of jointly recommending a candidate remain subject to the proxy rules.272

One commenter recommended that the Commission limit the number of security holders in a group that are identified when the disclosure requirements are triggered.273 This commenter suggested identifying a lead security holder.274 One commenter suggested that nominating security holders be permitted to nominate only "bona fide director candidates that will represent the interests of all security holders."275

One commenter recommended revising the disclosure of nominating committee policies to reflect changes made over time (e.g., 3-5 years).276

Four commenters asked that the Commission harmonize the proposed rules with the proposed NYSE listing standards.277

A. Observations About the Proposed Rules Regarding Communications Between Security Holders and Boards of Directors

One commenter expressed concern that disclosing information about security holder communications does not address the board's refusal to address or act upon security holder communications.278 Another commenter strongly recommended, however, that "any rules [related to communications with boards] be truly limited to disclosure rather than be a vehicle which actually serves as a prescriptive substantive requirement."279 This commenter was concerned that "rules of this nature would sweep in a substantial amount of immaterial disclosure and require a substantial amount of immaterial and inappropriate activity."280 Two commenters noted that each company should be permitted to establish whatever policy it deems appropriate.281

Several commenters pointed to potential problems in complying with Regulation FD, disclosing proprietary and confidential information, and competitive concerns. One commenter noted that directors "need to be concerned about prematurely disclosing material information, complying with Regulation FD, being sensitive to information which may provide a third party with competitive or other advantages, and the management of proprietary or confidential company information."282 Two commenters noted that certain security holder communications may involve material non-public information, information that may influence a security holder's investment decisions, or matters that might be the subject of a Request for Confidential Treatment under the Freedom of Information Act.283 These commenters noted the potential consequences of the interplay between Exchange Act Rule 10b-5, Regulation FD, and FOIA.284 Another commenter argued that the new requirements may lead security holders to violate Commission regulations by leading them to believe they can freely communicate with directors without "making SEC filings."285 This commenter suggested abandoning the proposed requirements and instead recommended "finding ways to promote the free speech of shareholders."286 Another commenter noted there are restrictions on the ability of management and boards to conduct a dialogue with individual security holders, citing Regulation FD as an example.287

As a result of these considerations, one commenter stated that boards often channel communications through a spokesperson and that each company should be free to establish its own policy for communications.288 Another commenter noted that, to the extent the subject matter of a proposal involves confidential communications, companies may decline to have conversations because of the "significant liability exposure."289 One commenter noted that companies should be asked to clear responses with their general counsel.290

B. Response to Questions Regarding Disclosure of the Ability of Security Holders to Communicate with Boards of Directors

1. Would increased disclosure relating to security holder communications with board members be an effective means to improve board accountability, board responsiveness, and corporate governance policies? Would this disclosure be useful to security holders?

There was no clear consensus as to whether the proposed rules would be an effective means to improve board accountability, board responsiveness, and corporate governance policies. Some commenters believed this information would be useful to security holders. For example, one commenter expressed the view that this disclosure would provide security holders with important information that provides an understanding of a company's process for communications with the board.291

Other commenters did not believe that the proposals would be an effective means to improve board accountability, board responsiveness, and corporate governance policies and were of the view that the disclosure would not be useful to security holders. For example, one commenter stated, "More detailed disclosure along the lines of the proposed rules would not further the Commission's objectives of promoting director accountability, responsiveness and improving corporate governance policy, and will simply burden proxy statements with additional disclosure of interest to few security holders."292 Other commenters believed that the proposed rules would not solve issues of director accountability293 or increase transparency to boost the ability of investors and the public to make informed investment decisions efficiently.294

One commenter explained that security holders do not need a better understanding of the process because this information is already available.295 Another commenter indicated that the proposed disclosure would not provide security holders with useful information and noted that the amendments to the NYSE listing standards, (i.e., section 303A(3)) would require listed companies to disclose a method for interested parties to communicate with non-management directors.296

2. If so, do the proposed specific disclosure standards, including those in each of the following areas, provide security holders with important information that provides an understanding of a company's process for communications with the board:

the existence of such a process;

a description of the manner in which security holders can communicate with the board;

identification of board members to whom communications can be sent;

One company noted that, while explaining the procedure to communicate with directors may be appropriate, it would not be fair to name specifically those directors who have agreed to receive mail directly because this disclosure may make these directors targets of inappropriate requests to the board. This commenter further explained that most communications aimed at directors are not appropriate for resolution in the boardroom.297 Another commenter recommended that the company be required to identify only board members to whom communications cannot be sent.298

the process, if any, for determining which communications will be passed on to board members; and

Several commenters were critical of this portion of the proposed rules. For example, three commenters noted that company personnel must play some role with respect to security holder communications to directors and disclosure about this would not be meaningful and likely would result in boilerplate disclosure.299 Another commenter believed that it is "inappropriate" to require a description of the filtering process, which involves internal administrative detail.300 One commenter noted that "disclosure of the details of how and which communications will be relayed to the board is impractical to provide given that such matters are almost always based on subjective decisions by those who are responsible for screening communications."301

Other commenters recommended clarification of this portion of the proposed rules. For example, one commenter noted that the proposal did not make clear the required level of detail with regard to the screening process.302 Another commenter urged the Commission to clarify that the proposed requirement is intended to require disclosure of a process whereby a department or other group within a company "filters" communications (which includes a determination not to send certain communications to the board of directors) and not a process whereby a department or group is designated to receive, collate, and summarize communications for the board (including consolidating duplicative communications).303

a description of material actions taken as a result of security holder communications with the board?

Several commenters were critical of this proposed disclosure requirement. One commenter believed that requiring disclosure regarding any material actions taken in response to security holder communications is "unnecessary, probably counterproductive and should be deleted."304 Another commenter believed that this disclosure would not be meaningful.305

Commenters were critical of the proposal for a variety of reasons. Four commenters noted that boards make decisions based on input from a variety of sources and it would, therefore, be difficult and not useful to attempt to determine whether a nexus existed between a security holder communication and board action.306 Eight commenters indicated that it was unclear what would constitute a "material action."307 For example, one commenter raised the possibility of an action the board would have taken with or without the security holder communication and questioned whether this would be a material action taken as result of the security holder communication.308 Given these uncertainties, one commenter recommended additional guidance on this disclosure point.309

Other commenters noted that there would be negative consequences as a result of the proposal. One commenter explained that disclosure about who receives "credit" for a corporate action is not sensible and noted that the proposed rules may inhibit communication with security holders.310 One commenter further explained that this disclosure requirement would:

[A]dversely affect the on-going dialogue that has developed between corporations and their larger security holders, and the positive results to improving corporate governance that often result. Corporations frequently consult informally with larger security holders regarding contemplated courses of action (for example, consideration of new stock options or other management incentive plans), as well as entertaining suggestions from such security holders, including on matters which the board may already be considering and wishes to continue to consider in a non-public manner (for example, consideration of greater board independence or business restructuring initiatives). . . . Disclosure of material actions by an issuer is already required. We believe that any requirement for issuers to attribute the motives for such action will be counter-productive and we would suggest that the Commission leave it to the interested parties to determine how much to disclose with respect to the impetus for any particular action.311

Another commenter indicated that this portion of the proposed rules would divert the focus and energy of the board away from its oversight responsibilities.312

3. As noted above, the proposed disclosure standards are intended to provide security holders with specific, detailed information that we believe is important.

Are there alternative means to better achieve our objectives?

Several commenters suggested that the Commission permit the use of electronic media to make disclosures. For example, one commenter recommended that the communication process be described in general terms in the proxy materials, with specific details about the communication process posted on the company's website.313 Two commenters suggested encouraging companies to disclose this information on their websites.314 One commenter recommended that companies be encouraged to post on their websites letters from security holders and any responses.315

Other commenters recommended different disclosure alternatives for the Commission to consider. One commenter suggested that the Commission create a database of policies concerning security holder communications and make this information available to the public.316 One commenter recommended that the Commission require boards to report back to investors "a summary of security holder  Director communications, actions taken in response to security holder concerns, and if the Board did not respond to particular communications, which executives did and why."317

For example, would it be more appropriate to include a broader, less detailed disclosure standard? Would any of the detailed disclosure requirements within the proposed standard result in disclosure that is unnecessarily detailed for the purpose of providing security holders with important information regarding the process of communicating with the board? If so, please describe specifically the basis for that conclusion.

One commenter noted that the Commission does not cite any empirical evidence of widespread concern or commentary indicating security holders' desire for detailed disclosure about processes to communicate with directors. This commenter believed the detailed disclosure proposed is not useful to security holders.318 As such, this commenter recommended that disclosure be limited to whether the company has a process and how security holders may communicate with directors.319

4. Security holders who desire to communicate directly with individual directors, committees, and independent members of boards often are uncertain of the procedures to follow to contact directors. As such, we have proposed requiring disclosure with regard to security holder communications with board members.

If no director accepts communications individually, should the company disclose why?

Two commenters believed that if no director accepts communications individually, the company should disclose why.320 One commenter disagreed and stated that companies should not be required to disclose why no director accepts communications individually as long as a process exists for the board to receive security holder communications.321 Another commenter suggested that we revise the disclosure requirement to clarify that purely ministerial activities, such as "organizing and collating" the communications, need not be disclosed.322

Should companies be required to disclose the process they use to record and keep security holder communications?

One commenter indicated that companies should be required to disclose the process they use to record and keep security holder communications.323 Another commenter was of the view that the nuts and bolts of how a company administers the process and how the board responds to security holder communications would not be meaningful and would not encourage companies to establish a process or respond to security holder communications.324

5. We have proposed requiring disclosure of the means by which companies "filter" security holder requests to communicate with board members.

Should there be disclosure of the specific person who determines which communications are sent to board members?

One commenter indicated that this disclosure was not necessary if the group involved in the filtering process is identified.325

Should there be disclosure of whether management plays a role in "filtering" the security holder communications that are intended for directors?

Three commenters indicated that there should be disclosure of whether management plays a role in "filtering" the security holder communications that are intended for directors.326

6. We have proposed requiring disclosure regarding any material actions taken in response to security holder communications.

Are there any categories of communications or actions that should be excluded from coverage of the rule?

One commenter expressed the view that no categories of communications should be excluded from the rule's coverage.327 Another commenter recommended limiting the disclosure requirement to communications regarding corporate governance matters "that would be of general interest to stockholders."328

For example, should the rule only apply to formal petitions to the entire board?

Two commenters recommended limiting the requirement to a description of material actions taken as a result of formal petitions from security holders.329 Another commenter did not believe that the rule should apply only to formal petitions to the entire board.330

Should this rule address specifically security holder proposals under Exchange Act Rule 14a-8? For example, should the rule make clear that disclosure is not required with regard to communications relating to proposals under Exchange Act Rule 14a-8? Alternatively, should those communications be included specifically within the disclosure requirement?

One commenter emphasized that it would be "particularly inappropriate to exclude proposals under [Exchange Act] Rule 14a-8 from the definition of communication" given companies' non-responsiveness to non-binding security holder proposals.331 Two other commenters noted that Exchange Act Rule 14a-8 communications should be expressly excluded.332 One commenter stated, "Both the security holder proponent and the company are subject to specific, detailed requirements, conditions and deadlines, including regulation of the content of statements about the proposal. The rationale given in the Release is that requiring disclosure of such material actions is significant to security holders in evaluating the quality and responsiveness of the communications process. However, in the case of [Exchange Act] Rule 14a-8 proposals, if the security holder satisfies the conditions of the Rule, the company is required to include the proposal in the proxy statement and report the results in a [Exchange Act] Form 10-Q. There is no need to impose another disclosure requirement on this process."333

7. Do companies currently provide a means for allowing security holders to communicate with board members?

Several commenters noted that some companies have set up a process for communications with outside directors.334 Another commenter noted that a few companies provide a means for allowing security holders to communicate with board members, but most do not.335

One commenter stated that some companies provide disclosure in their proxy statements or on their websites relating to how security holders can contact non-management directors and/or the chairs of board committees.336 In addition, this commenter noted that the corporate secretary or investor relations personnel facilitate communications and/or meetings between security holders and directors.337 Another commenter stated its belief that security holders are already "effectively communicating with directors through formal and informal processes."338 One commenter specified that security holders currently can communicate with directors through Exchange Act Rule 14a-8, proposals made on the floor, or statements made at an annual meeting.339

If so, how effective have these methods been in improving board accountability, board responsiveness, and corporate governance policies?

One commenter noted that current methods have not been effective in improving board accountability, board responsiveness, and corporate governance policies.340 One commenter stated that board members "rarely respond" to security holder communications.341 Several commenters indicated that board members rarely respond to communications from security holders, and letters and emails often are filtered through the Investor Relations department or by corporate executives.342 One commenter noted, "While we have had many positive interactions with board directors, we have had several experiences in which our letters to board directors have gone completely unacknowledged. In other cases, management has responded, supposedly speaking for the director(s)."343 Another commenter noted that it researched 3000 companies annually, and it was rare to receive "prompt, complete information from companies and directors in response to our queries."344

One commenter noted that those companies that have established electronic mail addresses have found that the majority of communications address either consumer matters or are unsolicited, mass communications.345

Is it easier for larger minority security holders to communicate with board members?

One commenter noted that it is easier for larger minority security holders in small companies to communicate with the board.346 Two commenters indicated that it generally is easier for larger security holders to communicate with board members.347

8. Because not all companies would be subject to any listing requirements that would allow security holders to communicate with board members, would a disclosure requirement alone be sufficient with regard to companies not subject to those listing requirements?

One commenter believed that a disclosure requirement alone would be sufficient with regard to companies that are not subject to the listing requirements.348

Other commenters believed that investors should have direct access to board members, similar to the NYSE listing standards.349 Another commenter urged the Commission to require boards of publicly-traded companies to establish means by which security holders may communicate directly with boards.350

9. Should communications with board members that are addressed in the disclosure requirements be limited to independent directors or extend to the entire board?

Commenters varied in their response to whether the disclosure requirements should be limited to independent directors or extended to the entire board. Four commenters believed that the disclosure requirements should apply to both independent and non-independent directors.351 Several other commenters noted that it is more important to speak with independent directors because these directors sit on key board committees.352 One commenter expressed the view that each company should be permitted to establish a process and determine to whom the communications should extend.353

Three commenters noted that the NYSE's listing standards would apply only to communications with non-management directors, while the proposed rules would apply to communications with all directors.354 One of these commenters suggested that there should be a mechanism to communicate with all directors, including non-independent directors who typically have more information with which to respond to security holder concerns.355 Another commenter encouraged the Commission to harmonize these requirements.356 The third of these commenters believed that "any proposed rules should be consistent with, and not more extensive than, any final listing standards adopted by the NYSE."357

10. We are using the term "communications" very broadly to discourage companies from taking a formalistic view as to disclosure regarding which communications are relayed and considered. We do not, however, intend this disclosure standard to require disclosure regarding communications with the board of directors from management of the company, employees of the company, or other agents of the company, where such persons happen also to be security holders.

Should we include a specific limitation on the term "communications" in this disclosure standard?

Three commenters believe that the exception for communications with the board from management, employees, or other agents of the company should be expressly included in the rules.358 One of these commenters recommended leaving the company with the discretion to determine which communications from management, employees, or other agents should be excluded.359

If so, how do we prevent companies from taking an unduly restrictive view of the term "communications" for purposes of this disclosure standard?

One commenter recommended that the Commission prevent companies from taking an unduly restrictive view of the term "communications" by "making sure companies fully understand and comply with the spirit of the regulation."360

11. The proposed rules relating to communications are disclosure standards only and would not require companies to establish procedures for security holders to communicate with directors.

Should we nonetheless provide guidance to companies or otherwise address what we would view as appropriate procedures for companies to implement with regard to security holder communications with board members? If so, what procedures would be most appropriate and why?

Two commenters stated that the Commission should not require specific procedures for security holder communications with board members because these procedures will vary from company to company.361

One commenter suggested that the Commission offer manuals describing policies and procedures that the Commission believes are best practices.362 One commenter noted that best practices are readily available without Commission guidance.363

What would be the cost to companies of implementing and maintaining such procedures? How much time would directors and other company personnel be required to expend in implementing and maintaining such procedures?

Two commenters believed that the rules could be "extremely costly, time-consuming and potentially disruptive."364 These commenters explained that the proposed rules could increase significantly the number of communications that are sent to board members and, the more directors must divide their time, the less effective those directors will be in fulfilling their obligations.365 Another commenter stated that a cost may be that the board is distracted from its primary duty of overseeing management and the business of the company.366

What other unintended burdens or other consequences would fall on directors as a result of such procedures? Could we give useful guidance in this area and, if so, how?

One commenter suggested that the Commission could give useful guidance by cataloguing the most likely burdens and consequences.367

C. Other Recommendations Related to Disclosure Regarding the Ability of Security Holders to Communicate with Boards of Directors

Commenters made several other suggestions regarding the ability of security holders to communicate with directors, including the following:

Several commenters recommended that companies be required to disclose their policies regarding directors' attendance at security holder meetings and the directors' specific attendance at the security holder meetings in the report disclosing the security holder vote for director elections.368 At least three commenters recommended that these disclosures appear in companies' Exchange Act Forms 10-Q.369 One commenter noted, "We are aware of corporate annual meetings in which no member of the board of directors attends. In other cases, directors' attendance at board meetings is spotty."370

One commenter believed that an external third party should filter information received from security holders.371

One commenter recommended that companies be required to include each director's mailing address, phone number, fax number, and email address.372 This commenter recommended that this disclosure be available in Exchange Act Forms 10-K and 10-Q, on company websites, and with company operators.373

Two commenters noted that the amendments to NYSE listing standards would require a method for interested parties to communicate confidentially with directors, which the commenters believed was not necessary or practical.374 One commenter recommended that companies be required to disclose a method to allow security holders confidential access to communicate directly with the presiding director or other non-management board members.375 Another commenter noted, "Corporations frequently consult informally with larger security holders regarding contemplated courses of action (for example, consideration of new stock options or other management incentive plans), as well as entertaining suggestions from such security holders, including on matters which the board may already be considering and wishes to continue to consider in a non-public manner (for example, consideration of greater board independence or business restructuring initiatives). Institutional security holders have indicated to us that some of their greatest successes have come as a result of such confidential discussions with companies, and they strongly believe that private, confidential discussions should continue to be permitted without disclosure considerations beyond those currently required under present law and regulation."376

Several commenters recommended requiring security holders to conform to certain rules and requirements. One commenter believed that companies should be expressly permitted to set certain guidelines for communications from security holders (e.g., typed or handwritten letter).377 This commenter also recommended that the proposal should clarify that a company may establish and enforce specific requirements that must be met by nominating security holders including deadlines and provision of specific information.378 Another commenter recommended that security holders be required to provide certain information regarding ownership and holding period of their securities.379

One commenter recommended that the Commission consider a rule that would enhance board and security holder communications at annual meetings.380

Two commenters recommended requiring disclosure of policies for how individual/small security holders can communicate with boards, if that policy differs from institutional investor communication policies.381

VI. Investment Companies

A. Should the proposed amendments that would require disclosure regarding the operations of the board nominating committees apply to funds? Should the proposed amendments that would require new disclosure concerning the means by which security holders may communicate with members of boards apply to funds? Are there any aspects of the proposed amendments that should be modified in the case of funds?

Several commenters supported requiring investment companies to provide the proposed disclosure.382 One commenter noted that the disclosure rules should apply to investment companies because many investors are dependent on mutual funds for nearly all their retirement income.383

One commenter recommended that funds be allowed to file notices regarding changes to the nominating procedure in a Form N-CSR because investment companies are not required to file quarterly or current reports.384

B. Should we apply the "interested person" standard of Section 2(a)(19) of the Investment Company Act in requiring disclosure regarding the independence of members of a fund's nominating committee? Should we instead apply a different standard to funds, such as the listing standards of national securities exchanges or national securities associations?

One commenter supported a requirement that investment companies include a description of which members of the nominating committee are "interested persons" under the Investment Company Act.385 Another commenter stated, "We believe that the Commission should apply the Investment Company Act Section 2(a)(19) standard because it is consistent with all other requirements of the Investment Company Act and is understood by funds, directors and their affiliates. Applying another standard could result in unnecessary complication or confusion."386

C. Other Comments Related to Investment Companies

One commenter stated, "Given the unique nature of funds and the relationship to their service providers, we believe that it would be sufficient to require funds to disclose the general nature of the source of the nomination, such as `an officer of the advisor' or `a director of a public company who is not an interested person of the fund.'"387 Another commenter questioned whether this information would be relevant, as the Investment Company Act requires independent directors to select and nominate other independent directors.388

Similar to the arguments raised with regard to operating companies, one commenter indicated that the additional disclosure for holders of more than 3% of a fund is not necessary because the Investment Company Act requires independent directors to nominate and approve candidates.389 Another commenter recommended an ownership threshold lower than 3% for mutual funds because mutual funds have fragmented investor bases consisting mostly of individual investors rather than institutional investors.390

One commenter noted that funds have a policy of maintaining passive investor status under Exchange Act Section 13(d). This commenter noted that this does not prevent funds from having discussions with management or the board about their concerns; however, the proposed rules may discourage funds from discussing their concerns in order to avoid any Exchange Act Section 13(d) interpretations.391

VII. Small Business Issuers

A. Applicability of the Proposed Rules to Small Business Issuers

Several commenters supported requiring small companies to provide the proposed disclosure.392 In this regard, commenters stated, "enhanced disclosure would be of great value to all types of investors."393

Other commenters recommended granting outright relief to small businesses or deferring application of the rules to small businesses until the Commission evaluates the impact of the rules.394 One commenter suggested that small companies that have established procedures could comply voluntarily.395

These commenters sought relief for small businesses for several reasons. One commenter recommended that the Commission not apply the rules to small businesses because it will "waste the money of small publicly held companies, create confusion ... and provide no useful service to security holders."396 This commenter noted that there does not appear to be a significant number of instances where major security holders of small publicly held companies were unable to communicate with boards of directors, particularly because major security holders are in management and/or on the board.397 Further, this commenter was of the view that, because major unaffiliated security holders potentially can impact the trading price of small business securities, management and the board "take the views of major unaffiliated security holders very seriously."398 This commenter also noted that the board and security holders will not agree on every aspect of running the company and it is not clear why small businesses need to set up a procedure for every communication with security holders.399

One commenter suggested that the Commission conduct a survey to assess the quantitative costs to small businesses after the final rules have been adopted and in force for two years.400

B. Specific Comments on the Proposed Rules and Their Impact on Small Businesses

One commenter did not support requiring smaller companies to analyze a nominee's independence when it is not otherwise required to perform this analysis.401

One commenter noted that a potential unintended consequence of the proposed rules would be that small business issuers would opt to eliminate the nominating committee rather than provide the detailed disclosure that would be required.402

VIII. Paperwork Reduction Act

The majority of commenters did not comment on the hours and cost burden to companies as a result of the proposed rules. One commenter noted that given the number of companies who are unlisted, it is difficult to estimate the compliance burden.403 One commenter believed that the disclosure burden for the proposed rules could be as high as twelve hours for the first year and four hours for following years.404

IX. Cost-Benefit Analysis

Some commenters believed that there would be significant costs associated with the proposed rules. One commenter noted that the initial cost of implementing and maintaining procedures would be high.405 This commenter noted that the cost would include time, money, and other corporate resources used to create and document nominating committee policies and procedures. These resources, according to the commenter, would come from security holders.406 Further, this commenter was of the opinion that the proposal, as currently structured, would raise the cost of investing by increasing the amount of time that must be spent monitoring corporate activities.407 This commenter also noted that this proposal would result in significant compliance costs. The commenter stated, "First year costs are likely to be higher than subsequent year costs. These costs include legal fees associated with structuring and reviewing policies, management time cost related to structuring policies, fees paid to accountants for managerial and financial statement creation and review, opportunity costs related to missed business opportunities, and many other costs."408 One commenter believed that the rules could be time-consuming, extremely costly, and potentially disruptive.409 This commenter explained that the proposed rules could increase significantly the number of communications that are sent to board members, and the more corporate directors must divide their time, the less effectively they will discharge their competing functions.410 Two commenters believed that the proposed disclosure requirements would increase the burdens of boards and discourage service.411

Other commenters believed that the cost for companies would be low. Two commenters noted that the rule would provide useful information at little cost.412

One commenter believed the costs would be different on a company-by-company basis.413 This commenter noted that the proposed rules would not result in much, if any, additional cost for companies that already have a security holder communications process.414 For companies that do not have a system in place, this commenter believed that the proposal would burden company resources by requiring a person to administer the communications system.415

One commenter believed that both the cost of submitting candidates to the nominating committee and the probable benefits would be minimal.416 This commenter noted that, even if a nominating committee is composed entirely of independent directors, it is not likely to put forward a candidate recommended by security holders.417

Other commenters cited to the costs to small businesses. One commenter believed that the increased benefits of disclosure would not outweigh a small business issuer's need to reduce expenses.418 Another commenter stated that small companies can "ill afford the greater expense of being public."419 One commenter noted that it is flawed to increase the incremental cost to small businesses by a certain number of hours and assume that adequate staff is presently available.420 This commenter noted that as regulatory requirements increase, small businesses will have to hire additional staff or reduce the number of hours spent managing the company.421 One commenter noted that with regard to small businesses, the burden carried by outside professionals would be greater than 25% because small entities would not have the "sophisticated staff" to provide the disclosure mandated.422 This commenter suggested that the burden would be undertaken 25% internally and 75% externally.423

X. Other Related Recommendations

Commenters made several other recommendations that did not address directly the issue of disclosure regarding nominating committee functions and communications between security holders and boards of directors.

One commenter recommended that the Commission change "security holders" to "shareholders" because the proposed rules should not apply to holders of debt (convertible or otherwise), non-voting preferred stock, or other financial instruments.425

One commenter recommended having "true public financial representatives" on every board.426

One commenter recommended exempting from the disclosure requirements companies that are "majority-controlled by one person or entity and, therefore, are not required to solicit proxies."427

One commenter recommended required proxy statement disclosure by the board of those board duties that investors generally consider to be of paramount importance. "Director involvement in corporate strategy development and succession planning," according to this commenter, "are two important board duties that are universally cited by business, academic and investor studies of corporate boards."428

One commenter recommended that "a company should be required to report to security holders what actions, if any, the board of directors has taken with regards to any shareholder proposal that received a majority shareholder vote at the corporation's annual meeting. The disclosure should include a description of the proposal issue and the specific actions, if any, that the board has taken or will take regarding implementation of the proposal." This commenter recommended that this information be disclosed in an Exchange Act Form 10-Q following the annual meeting.429

One commenter recommended that the board establish performance criteria, including the level of a director's attendance, preparedness, participation, and candor.431

One commenter recommended that the "SEC can suggest a Shareholder/Stakeholder Committee, comprised of three to four independent directors, that serve as a liaison between investors, stakeholders, and the Board-at-large."432

30 See e.g., Letter B; SIF. See also Thompson ("The high costs and legal complications of running a candidate for election to a company's board create an insurmountable barrier to effective security holder participation in the nomination and election of directors.").

270 See ACCA; NYCBAR. ACCA recommended a modified version of the procedural requirements in Exhange Act Rule 14a-8 to allow the company a longer time to provide notice of a deficiency in proof of ownership since the board may have to convene a meeting to act on a security holder nomination.